Weakening economic environment slows credit growth

12/10/2017 20:21 AST

Liquidity of Saudi Arabian banks has improved significantly since last year but the slowdown in the economy is likely to lead to a rise in non-performing loans (NPLs), according to Fitch Ratings.

“The Saudi banking sector has one of the world’s lowest non-performing loan (NPL) ratios, at just 1.4 per cent of gross loans at end-June 2017. However, NPLs have been rising modestly and Fitch expects this to continue in 2017 and 2018, albeit at a manageable level,” said Andrew Parkinson, an analyst at Fitch Ratings

Saudi Arabia’s Annual economic growth is expected to remain below 1 per cent in 2017 and 2018. Negative internal ratings migrations reported by most banks in 2016 and the first half of 2017 are likely to translate into higher NPLs in the medium term.

Earnings metrics for Saudi banks are strong in a global context, with a sector return on assets of 1.8 per cent for 2016. However, in line with a weakening economic environment, credit growth has slowed, directly affecting earnings growth, which has plateaued for most banks and started to decline for others. We do not expect a significant improvement in 2017 credit growth and, considering asset-quality pressures, we cannot rule out a sector-wide earnings decline.

Fitch Ratings believes the biggest change in the Saudi Arabian operating environment since early 2017 is the easing of liquidity conditions. Most of the public-sector deposits that were drained from the banking system in 2016 in response to falling oil prices have since returned and the state has cleared the vast majority of its overdue payments to contractors. Most banks had liquidity coverage ratios above 200 per cent at end of first half 2017.

International sovereign debt issuance

Funding costs, which spiked during the 2016 tightening, have fallen back towards the very low levels to which most Saudi banks had become accustomed. Another wave of government deposit withdrawals is less likely now that Saudi Arabia is partly financing its fiscal deficit with international sovereign debt issuance.

Most banks’ internal rating assessments showed a decline in borrowers’ creditworthiness in 2016 and the first half of 2017 and there was a modest rise in the sector’s NPL ratio in the first half of 2017 to 1.4 per cent of gross loans. However, this is very low by global standards and loan-loss coverage is strong. “Even factoring in delinquent loans that are not impaired, watch-listed exposures and restructured loans, we consider the sector’s overall asset quality to be strong,” said Parkinson.

Earnings metrics for Saudi banks are solid by global standards, with a sector return on assets of 1.8 per cent or 2016. However, credit growth has slowed and, as a result, earnings have plateaued for many banks and started to decline in some cases. Fitch analysts expect a significant improvement in credit growth for 2017 and there is a risk of a sector-wide earnings decline given the asset-quality pressures.

Saudi banks are among the best capitalised globally, with a sector Fitch Core Capital ratio of 17.2 per cent at end-2016. Although higher impairment charges will affect capital ratios, slow loan growth and still-solid earnings should mean that sector capitalisation will continue to improve, with banks storing excess capital ready to deploy if and when the economy improves in the longer term.

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